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Housing bubble set to burst? |
As everyone knows the residential property market is booming even in areas where prices have been stagnant for years.
While there are a few cracks in some sections of the market, many smart investors are making a killing. Meanwhile potential first homebuyers are looking on in despair. The surge in prices has meant that home affordability has never been lower. Partly as a result, consumer debt is quite high and still rising.
So is this a dangerous situation or not? Has the property market developed a dangerous bubble quality that will one day burst and leave an ugly mess or is it just a part of the normal property cycle?
The Reserve Bank and indirectly the Federal Government are struggling to find the answer. There are of course electoral implications in all this. The only response so far has been a bit of jaw-boning.
The Reserve has been trying to talk the market down without actually doing anything. Strictly speaking, booming assets prices whether they are shares or property are not the concern of the Reserve Bank
The Reserve’s job is to keep consumer prices down – a job that it is doing admirably. However the Reserve, along with a number of other observers, is concerned the effect a sudden bust in property would have on the rest of the economy.
The IMF has also expressed concern about the damage a bursting property bubble might do. Recently the Reserve called a special conference on asset price bubbles and pulled in a number of international speakers to provide advice. Needless to say there is no unanimity. Some economists are even questioning whether or not a bubble exists, arguing that it is just a normal part of the property cycle and nothing to be alarmed about.
So what is a bubble and why is it dangerous? No one can agree on a definition but there are some characteristics that appear to be common to most so-called bubbles. They are characterised by rapid rises in price and subsequently steep falls.
The falls can be sudden or prolonged and are caused by speculators being forced to sell. They usually have an initial cause that is rational but that is quickly lost as speculation takes over. For example the dot.com bubble was driven initially by technology and the internet, but developed into a situation where people were buying stocks because they expected prices to continue to rise rapidly, presumably forever.
A bubble usually sees new entrepreneurs emerge trying to cash in on the speculation and greed. Cheap and easy credit is another characteristic. It also appears that investors have short memories and that they quickly forget that prices can go down as well as up.
The current surge in property prices has many of these features. Interest rates are low and it is easy to get credit. There is a strong underlying demand for housing from potential owner-occupiers because of high employment growth. Investor demand has also been strong because the share and bond markets over the past three years have offered little in the way of an alternative.
And of course the entrepreneurs are there, offering expensive seminars that promise instant wealth through property. But has wild speculation taken over? One recent study in the US, where the property market is in a similar state to here, suggests that it is developing that way. This study found that people are greatly influenced by recent history in their expectations of the future. The majority of US homeowners and investors surveyed strongly believe that house prices will continue to rise by double figures well into the future. They also believe that housing is a much safer investment than shares.
For this reason most of those surveyed believe that despite the large hike in prices, now is a good time to buy property because it will be too expensive later on. Anecdotal evidence suggests that many share the same view here.
So how dangerous is all this? A number of studies have shown that the wealth effect with property is stronger than with other assets including shares. The wealth effect kicks in when property prices rise and owners, whether they are sellers or not, feel more wealthy than before. They then spend and borrow more. The danger is that a fall in prices will have the reverse effect. Feeling less wealthy, they will stop borrowing, they will cut spending and increase savings.
It is important to remember that it was only strong consumer spending in the US and Australia over the last few years that allowed both economies to survive the shocks of September 11, SARS, the Iraq war, the drought, the threat of deflation and the collapse of the dot.com bubble. As the world economy recovers more strongly, the pressure will be on the Reserve Bank to lift interest rates to keep inflation down. But too high a hike could cause the property market to collapse. While some see this as a real risk, others do not.
For example Michael Knox, chief economist at broking house ABN Amro Morgans, believes there is no housing bubble – except in Victoria where there has been some over-building. His analysis suggests that the strong demand for housing over recent years is in line with the increase in incomes.
If he is right then there will be few forced sales from slightly higher interest rates and consequently no bursting of a bubble. Instead the heat will go from the market, prices will plateau rather than fall and the economy will remain strong.
His argument is bolstered by the fact that house prices tend to be sticky on the downward side. Owners would rather not sell than get a price below their expectations.
Hope he’s right.
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